Small Businesses Counting on Loan Forgiveness Could Be Stuck With Debt

WASHINGTON — The embattled small business lending program at the center of the Trump administration’s economic rescue is running into a new set of challenges, one that threatens to saddle borrowers with huge debt loads, as banks begin the tricky task of proving the loans they extended actually met the government’s strict and shifting terms.

The Consumer Bankers Association warned on Wednesday that loan forgiveness is the “next shoe to drop” for the program, and the Independent Community Bankers of America raised alarm that struggling borrowers have been misled.

“Virtually every small business borrower believes that this will be forgiven,” said Paul Merski, a lobbyist for the Independent Community Bankers of America. “They took it out assuming that it would be a grant but it’s not — you have to abide by very complex rules and regulations on how this is spent.”

One of the biggest stumbling blocks is a requirement that businesses allocate 75 percent of the loan money to cover payroll costs, with only 25 percent allowed for rent, utilities and other overhead. That has become more difficult as the economic crisis from the virus drags on and as some businesses face a prolonged period of depressed sales, even once they reopen.

Some businesses are facing smaller payroll expenses because workers have opted to accept more generous unemployment insurance benefits, while only a handful of states have so far allowed businesses to reopen.

The I.C.B.A., which represents smaller banks, asked the Treasury and the Small Business Administration on Wednesday to require only half of the loans made through the aid program to be spent on payrolls and allow the loans to be split evenly between paying workers and covering rent, which remains a substantial expense for many businesses.

“Now that over $500 billion of these loans have been approved, we’re really focused on the forgiveness phase, and the forgiveness phase could be 10 times more complex than the initial program,” Mr. Merski said.

Mr. Mnuchin indicated last week that while he believed he had the authority to change the payroll requirement rules he was not inclined to do so given that the intent of the program was to maintain ties between businesses and workers while much of the economy was shut down.

“The objective here is to put people back to work,” Mr. Mnuchin said, adding that he did not want to encourage businesses to choose overhead costs over workers.

But that is not how things have unfolded for small businesses. Many laid off their workers to wait out the economic shutdown, intending to rehire as many as possible after it ended.

Douglas Geller, the co-founder of Wittmore, a clothing boutique for men with three locations in Los Angeles, laid off his six employees after closing on March 17. California is allowing some retailers to open on Friday for curbside pickup only, so Mr. Geller may hire one or two of them back, but only if Wittmore’s business seems viable under the state’s new restrictions.

Mr. Geller managed to get a small business loan just a week ago, but he now thinks the money arrived too early, since the rules of the program are forcing him to spend it in the next eight weeks, even though he cannot fully reopen his stores yet. He is counting on the Treasury Department to make changes to the forgiveness terms.

“We’re not alone,” he said. “I’m friends with other retailers, from the department store level down to mom-and-pop small businesses, everyone has these similar concerns: Forgiveness and the pace of reopening.”

Trade groups have been warning Treasury officials for weeks about the coming conflict over forgiveness.

“Since the program first launched, A.B.A. has been urging the S.B.A. and Treasury to provide clear forgiveness guidance as soon as possible,” said James Ballentine, a lobbyist for the American Bankers Association.

The S.B.A. said on Tuesday that 5,411 lenders had approved $181 billion in loans since the second round of the program was initiated last week. The program, which began on April 3, has experienced high demand but has suffered from technical glitches that stalled loan processing and poor optics as big, publicly traded companies reported receiving millions of dollars while smaller businesses have been shut out. Backlash over those disclosures prompted Treasury to rewrite rules on the fly.

The Treasury Department issued new guidance on April 23 urging big companies with the ability to access other financing to rethink whether they really needed the money. Mr. Mnuchin has given those borrowers until May 14 to return the funds, no questions asked.

Some borrowers believe that in changing the rules after the fact, Treasury has gone against the letter of the law, which waived requirements for businesses to seek funds elsewhere before applying for loans through S.B.A.

This week, Zumasys, a small technology company in California, and two of its subsidiaries, filed a lawsuit against the Treasury Department, Mr. Mnuchin, the S.B.A. and Jovita Carranza, the S.B.A. administrator, claiming that the latest guidance was unlawful. The company, which has fewer than 50 employees, received a $521,500 loan that it used for payroll costs and now it fears that it might have to repay that money. According to the complaint, Zumasys had access to other credit sources but the small business loan was the only option available that would have provided funds that did not need to be repaid.

“This guidance, which essentially imposes new requirements upon PPP borrowers, is not in accordance with the law and damages companies to the extent it jeopardizes their eligibility for PPP loans and calls into question the good faith behind their certifications,” said Mona Hanna, a lawyer at Michelman & Robinson, LLP, who is representing Zumasys and its subsidiaries.

The uncertainty is emerging as lawmakers and the Trump administration begin debating another economic relief bill. While the initial rounds of funding anticipated businesses needing just short-term bridge loans, the economic devastation from the virus shows no signs of abating, suggesting more help is likely needed.

“I think it was the intent to have a short-term boost to small businesses to get them through a short-term problem,” said Ann Marie Mehlum, a former associate administrator of the Small Business Administration’s Office of Capital Access. “I think the problem isn’t as short term as what everyone expected two months ago.”

The next legislation, which will take shape later this month, could include another round of funding for the small business loans but would likely come with changes to the program to reflect the more protracted collapse in business activity.

Speaking on the Senate floor this week, Republican Senator Marco Rubio of Florida said that the biggest problem with the Paycheck Protection Program has been that it was underfunded.

“The demand is greater than the supply,” said Mr. Rubio, who last week suggested that Treasury could use its regulatory authority to give borrowers more flexibility in how they use their loans.

Mr. Mnuchin and Ms. Carranza held a briefing on Wednesday with members of the Senate Small Business Committee, whose top lawmakers helped create the new small business program.

“We recognize that when we crafted the program, eight weeks, we thought, would be enough — we now know that our economy is not going to be up and running within that eight-week period in most of the country,” said Senator Ben Cardin, a Maryland Democrat and one of the lead negotiators behind the program’s formation.

On Tuesday, more than 20 bipartisan senators urged Mr. Mnuchin and Ms. Carranza to change the loan forgiveness criteria to allow small businesses, and particularly restaurants, to use the program, saying just 50 percent of the loan should be devoted to payroll, with the rest paying for other overhead.

“If they are unable to cover these expenses, they will have to decide between keeping their doors open, at personal financial risk, or closing shop and laying off employees,” the senators wrote.

Emily Cochrane contributed reporting.

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